TY - CHAP

T1 - Performance measurement systems

T2 - Beyond generic actions

AU - Lueg, Rainer

AU - Nørreklit, Hanne

PY - 2013/8/22

Y1 - 2013/8/22

N2 - Over recent decades, academics and practitioners have discussed the weaknesses of traditional and advanced fi nancial performance measures which incorporate cost considerations. In particular, return on investment (ROI) – as a ratio based on historical accounting information – has major shortcomings in measuring the fi nancial results of organizational units and in motivating management. First, it ignores the fi nancial value of intangible assets such as research in progress, human resources and the competitive position. Due to asset valuation, depreciation policy and lack of instruction about the cost of capital, ROI furthermore has serious dysfunctional implications for investment decisions (Copeland, Koller, and Murrin, 2000; Dearden, 1969: 292; Nobel, 1990). To address some of the weaknesses of ROI, EVA has been advocated as an advanced alternative (Stewart, 1991). One of the strengths of EVA is the inclusion of opportunity costs in the performance assessment and hence in managerial decision-making. Additionally, EVA requires detailed adjustments of earnings and invested capital to move away from historical accounting principles towards more economic-based principles. Yet, empirical evidence shows that EVA has only marginally higher explanatory power in explaining stock returns than unaltered accounting fi gures (Biddle, Bowen, and Wallace, 1997). However, since the fi gure relies on past accounting information and disregards many other expectations of market participants, we suggest that the singular focus on such a narrow defi nition of shareholder value could distort fi nancial performance measurement, and motivate management to undertake dysfunctional, short-term actions or gaming at the expense of long-term profi tability. Finally, it should be noted that the conventional wisdom of accounting advocates NPV to be used for managerial decision-making. However, the success of the NPV technique depends on the ability to estimate cash fl ows and the project-specifi c weighted average cost of capital. When evaluating possible investments, many companies tend to focus on cost savings only and hence neglect the measurement of (in-)tangible benefi ts, the opportunity costs of the decision and the project-specifi c risk (Kaplan and Atkinson, 1989; Nobel, 1990).

AB - Over recent decades, academics and practitioners have discussed the weaknesses of traditional and advanced fi nancial performance measures which incorporate cost considerations. In particular, return on investment (ROI) – as a ratio based on historical accounting information – has major shortcomings in measuring the fi nancial results of organizational units and in motivating management. First, it ignores the fi nancial value of intangible assets such as research in progress, human resources and the competitive position. Due to asset valuation, depreciation policy and lack of instruction about the cost of capital, ROI furthermore has serious dysfunctional implications for investment decisions (Copeland, Koller, and Murrin, 2000; Dearden, 1969: 292; Nobel, 1990). To address some of the weaknesses of ROI, EVA has been advocated as an advanced alternative (Stewart, 1991). One of the strengths of EVA is the inclusion of opportunity costs in the performance assessment and hence in managerial decision-making. Additionally, EVA requires detailed adjustments of earnings and invested capital to move away from historical accounting principles towards more economic-based principles. Yet, empirical evidence shows that EVA has only marginally higher explanatory power in explaining stock returns than unaltered accounting fi gures (Biddle, Bowen, and Wallace, 1997). However, since the fi gure relies on past accounting information and disregards many other expectations of market participants, we suggest that the singular focus on such a narrow defi nition of shareholder value could distort fi nancial performance measurement, and motivate management to undertake dysfunctional, short-term actions or gaming at the expense of long-term profi tability. Finally, it should be noted that the conventional wisdom of accounting advocates NPV to be used for managerial decision-making. However, the success of the NPV technique depends on the ability to estimate cash fl ows and the project-specifi c weighted average cost of capital. When evaluating possible investments, many companies tend to focus on cost savings only and hence neglect the measurement of (in-)tangible benefi ts, the opportunity costs of the decision and the project-specifi c risk (Kaplan and Atkinson, 1989; Nobel, 1990).

KW - Management studies

UR - http://www.scopus.com/inward/record.url?scp=85073047876&partnerID=8YFLogxK

U2 - 10.4324/9780203101261

DO - 10.4324/9780203101261

M3 - Contributions to collected editions/anthologies

SN - 978-0-415-59247-5

SP - 342

EP - 359

BT - The Routledge Companion to Cost Management

A2 - Mitchell, Falconer

A2 - Nørreklit, Hanne

A2 - Jakobsen, Morten

PB - Routledge Taylor & Francis Group

CY - London

ER -